Must-Read: Ian Johnson: Xi’s China: The Illusion of Change

Posted on by Brad DeLong
“Lights of Shanghai” by David Almeida, flickr, cc

Must-Read: Ian Johnson: Xi’s China: The Illusion of Change: “Xi[‘s]… goal has been to recreate the early years of Communist rule…

…in the early to mid-1950s when his father was part of the ruling elite. Back then, according to official mythology, the party was clean and officials were upright, and the populace was content. Returning to this imagined past means strengthening, not weakening party control. If we briefly survey Xi’s actions… we can see this as the primary goal of his reforms. Most obvious and probably the most disappointing for optimists is the economy…. Most of Xi’s changes—such as incremental bank rate liberalizations or opening the stock market a bit wider to foreign investors—can more properly be viewed as technocratic tinkering. It’s true that a lot of small repairs can lead to an overhaul, but only if the changes are part of a broader plan with a clear goal. There has been no indication that such a plan exists—at least not one that would lead to a more open economy. It is possible that Xi might reverse course… but signs are not promising. A recent, outstanding piece of fly-on-the-wall reporting in The Wall Street Journal shows that despite Xi’s anger about the slowing economy, the slow growth itself has made him cautious and even less willing to push reforms…

Must-Read: Isabel Sawhill: Where Have All the Workers Gone?

Posted on by Brad DeLong

Must-Read: Isabel Sawhill: Where Have All the Workers Gone?: “Real wages have fallen by 28 percent for high-school educated men since 1980…

…making work much less attractive, but also signaling that employers are looking for a higher level of skill…. Disability rolls have been growing (primarily because of musculoskeletal and mental health issues)… [which] create[s] a disincentive to re-enter…. Now that women are almost half the labor force, the pressure for men to work has lessened. In the shorter run, it’s hard to tell how much of the recent sharp drop in employment is related to weak demand and how much to these longer-term factors…. A rather large group may simply be unemployable at an attractive wage and may have figured out how to get by without working very much….

Will workers reap from changing demographics?

Posted on by Bridget Ansel
Active retirement by Diego Cervo, veer.com

When Stevie Nicks sang about getting older, she almost certainly wasn’t thinking about the ramifications for the global economy. But it looks like the global economy is on the path toward a demographic landslide.

Wall Street Journal reporter Greg Ip argues that the world is on the verge of a “population implosion” that will have broad implications for the global economy—namely, the drop in population growth will push down economic growth rates. As Ip points out, a drop in the U.S. population in the 1930s provoked economist Alvin Hansen to coin the term “secular stagnation” for concerns about perpetually lower economic growth.

Hansen’s fears weren’t met back then, but what would a decline in population today mean for the global economy? To answer this question, let’s take a broad look at two areas: the supply of labor and the supply of capital.

When it comes to the supply of labor, an aging population means a shrinking of the global workforce. As Baby Boomers enter retirement in the United States, other countries are also aging, noticeably China. This decrease in the effective supply of labor might push up wages, if we assume the demand for labor will be relatively the same. That’s a big assumption, of course—but all things equal, a smaller supply of labor would push up wages in the short run.

When it comes to the supply of capital, an aging population would likely increase the supply of savings as well. As Ip notes, older workers save more of their income. So countries with relatively more old workers save more, which increases the supply of capital. This increase in the savings rate would, under a traditional neoclassical economics model, be another good sign for wages: More savings means more capital. And since capital is complementary to wages, this would improve labor productivity in the short run. So there’s another boost to global wage growth.

But in the long run, wage growth is determined by productivity growth in these models. And in recent years we’ve seen a decline in productivity growth. Weak productivity growth isn’t just a problem for the U.S. economy, but seems to be a problem for many countries around the world.

But we actually have an example of these trends playing out in miniature: Japan. The country has both an aging population and a high savings rate, but the result certainly hasn’t been higher wages for workers. In fact, the country’s much slower economic growth is more reminiscent of Alvin Hansen’s warning from the 1930s and the more updated versions of secular stagnation being floated today.

While demographics are certainly key shapers of economic reality, they don’t set our destiny in stone. They can bound our path in the future, but policy helps determine our ultimate course.

The question, then, is which prediction will come closer to the truth: Will a greying global workforce see wages increase and push back against economic inequality? Or will slower economic growth and secular stagnation be the themes of the future? Given the difficulties with predictions—especially those about the future—we’ll just have to wait and see.

Housing supply, rents, and economic mobility

Posted on by Bridget Ansel
Jason Furman by Charles Dharapak, AP Photo

The debate about the causes of declining geographic mobility in the United States continues apace with a new contribution from Jason Furman, chairman of the President’s Council of Economic Advisers. In a speech to the Urban Institute last Friday, Furman suggested that the restriction of zoning supply in metropolitan areas is not only a force for pushing down mobility rates, but also a source of higher inequality and lower productivity growth.

Stitching together a number of research papers, Furman lays out the following narrative: Tighter restrictions on land use in some cities reduces the supply of housing, boosting housing prices in those areas. And the higher housing prices increase inequality by boosting the value of homes of incumbent homeowners while throwing up a barrier to prospective residents who want to move in.

That last part is worth digging into more.

Furman says that higher rents reduce the payoff of moving to a new location. Consider, for example, a person who might want to move from San Antonio to San Francisco. She might be able to get a higher-paying job in San Francisco. But if the rent there is much more expensive, her disposable pay may not be that much higher than it would be in San Antonio. Why move to a new city if rent is going to eat away your raise?

Furman also points out that the decline in migration started at the same time as the increased regulation of land use around 1970. But it’s unclear how much of the decline in mobility can be laid at the feet of higher housing costs.

Furman cites research by economists Raven Malloy and Christopher L. Smith of the Federal Reserve, and Abigail Wozniak of the University of Notre Dame, showing a decline in moves from state to state, moves from one county to another county in the same state, and moves within a county. Research by Equitable Growth’s Marshall Steinbaum also shows that most moves in the United States are relatively short. High rents, however, are an unlikely explanation for why workers are less likely to move within a county as opposed to moving across state lines. As Furman notes, declining migration has many causes and the research has yet to untangle the relative importance of factors.

On the topic of inequality, allowing for more construction in high-demand urban areas might not unambiguously decrease inequality. If more buildings can be built on a given piece of land, the value of the land will increase even more. An individual apartment will rent for less, but the overall profits from owning the land will go up because there are now more apartments. As a result, the economic rent going to the people who own the land might go up. The share of economic output going to land instead of capital or labor would rise as disposable income for renters rises.

Now, there very well could be significant gains and improvements for the U.S. economy by lowering housing prices. Workers would be able to move to cities that they might not to be able to afford otherwise. But it’s worthwhile to kick the tires on this story to get a sense of just how much we would actually reap.

Must-Reads Found Up to Breakfast on November 23, 2015

Posted on by Brad DeLong

Must-Read: David Leonhardt: ‘Chicagonomics’ and ‘Economics Rules’

Posted on by Brad DeLong

Must-Read: David Leonhardt: ‘Chicagonomics’ and ‘Economics Rules’: “Adam Smith’s modern reputation is a caricature…

…He was a giant of the Enlightenment in large part because he was a careful and nuanced thinker. He certainly believed that a market economy was a powerful force for good…. Yet he did not have a religious faith in the market…. Lanny Ebenstein’s mission, in ‘Chicagonomics,’ is to rescue not only Smith from his caricature but also some of Smith’s modern-day acolytes: the economists who built the so-called Chicago school of economics…. Ebenstein argues that the message of the Chicago school has nonetheless been perverted in recent years. Many members of the Chicago school subscribed to ‘classical liberalism,’ in Ebenstein’s preferred term, rather than ‘contemporary libertarianism.’…

Dani Rodrik… has written a much less political book than Ebenstein has, titled ‘Economics Rules,’ in which he sets out to explain the discipline to outsiders (and does a nice job)…. Rodrik has diagnosed the central mistake… [of] contemporary libertarians have made… conflat[ing] ideas that often make sense with those that always make sense. Some of this confusion is deliberate… act[ing] as a kind of lobbyist working on behalf of the affluent…

Must-Read: Mark Thoma: Clinton on Glass-Steagall: Right or Wrong?

Posted on by Brad DeLong

Must-Read: Mark Thoma: Clinton on Glass-Steagall: Right or Wrong?: “Hillary Clinton said she opposed reimplementing the Glass-Steagall Act…

…which had been repealed in 1999. When the financial crisis struck in 2008, many people blamed the disaster on the removal of the restrictions Glass-Steagall had imposed on banks. However, the evidence doesn’t support this claim, which makes Clinton correct. But that doesn’t mean ending Glass-Steagall was a good idea or that repeal could never cause the kinds of problems that lead to a financial crisis, which makes her wrong…. Even though the repeal of Glass-Steagall didn’t cause the most recent financial crisis, why leave the risk in place?

Those opposed to reimplementing the Glass-Steagall sort of restrictions argue it would hamper bank activities and leave them at a disadvantage. But that’s largely because the banks aren’t the ones who will pay the bill if they’re wrong. In fact, they would likely get bailed out…. The costs associated with Glass-Steagall restrictions on bank activities are small relative to the benefits of avoiding another financial crisis, and the objections of the financial industry shouldn’t stand in the way of a more stable financial system.

Must-Read: Mark Thoma: An Essential Part of Job Creation Policy Is Missing

Posted on by Brad DeLong

Must-Read: Mark Thoma: An Essential Part of Job Creation Policy Is Missing: “Candidates have focused on how to create jobs that pay a decent wage…

…But there is an important facet of job creation that is being left out… the opportunity for advancement. People are taught that if they play by the rules, do well in school, go to college, find a job, and then show up every day and work hard, they will be rewarded. Over time they will move up the job ladder, their income will rise, and a time will come when life won’t be such a struggle. That won’t happen to everyone, of course, but workers need to be able to see a path to a better life. But the dream has faded….

As the opportunities to move up the job and income ladder have diminished over time, workers become discouraged, disenfranchised, and look for someone to blame. It’s immigrants, unfair opportunities granted to others through affirmative action, globalization that allows labor to be exploited in other countries at a cost to U.S. jobs – the list goes on and on. In many, if not most cases, the blame is misplaced, but the underlying anger with a system that broke its promise about “playing by the rules” is more than understandable. My goal is not to suggest some magical solution that will fix this problem quickly. It’s a difficult problem that will take time and concerted effort on a variety of fronts…M

What is the free-market solution to a liquidity trap? Higher inflation!

Posted on by Brad DeLong

Three seventeen-year old quotes from Paul Krugman (Paul R. Krugman (1998): It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap, Brookings Papers on Economic Activity 1998:2 (Fall), pp. 137-205):

Suppose that the required real rate of interest is negative; then the economy ‘needs’ inflation, and an attempt by the central bank to achieve price stability will lead to a zero nominal interest rate and excess cash holdings…

And:

In a flexible-price economy, the necessity of a negative real interest rate [for equilibrium] does not cause unemployment…. The economy deflates now in order to provide inflation later…. This fall in the price level occurs regardless of the current money supply, because any excess money will simply be hoarded, rather than added to spending…. The central bank- which finds itself presiding over inflation no matter what it does, [but] this [flexible-price version of the liquidity] trap has no adverse real consequences…

And:

A liquidity trap economy is “naturally” an economy with inflation; if prices were completely flexible, it would get that inflation regardless of monetary policy, so a deliberately inflationary policy is remedying a distortion rather than creating one…

Thinking about these three quotes has led me to change my rules for reading Paul Krugman.

My rules were, as you remember:

  1. Paul Krugman is right.
  2. If you think Paul Krugman is wrong, refer to (1).

They are now:

  1. Paul Krugman is right.
  2. If you think Paul Krugman is wrong, refer to (1).
  3. And even if you thought Paul Krugman was right already, go reread and study him more diligently–for he is right at a deeper and subtler level than you would think possible.

Let us imagine a fully-flexible distortion-free free-market economy–the utopia of the Randites. Let us consider how it would respond should people suddenly become more pessimistic about the future.

People feel poorer. Feeling poorer, people want to spend less now. However, today’s productive capacity has not fallen. Thus the market economy, in order to incentivize people to keep spending now at a rate high enough to maintain full employment, drops the real interest rate. It thus makes the future more expensive relative to the present, and makes it sufficiently more expensive to incentivize keeping real spending now high enough to maintain full employment.

The real interest rate has two parts. It is equal to:

  1. the nominal interest rate,
  2. minus the inflation rate.

If money demand in the economy is interest elastic, the fall in the real interest rate will take the form of adjustments in both pieces. First, the free-market flexible-price distortion-free economy’s equilibrium will shift to drop the nominal interest rate. Second, the equilibrium will also shift to drop price level will drop immediately and instantaneously. Then the subsequent rebound of the price level back to normal produces the inflation that is the other part of The adjustment of the real interest rate.

If money demand takes the peculiar form of a cash-in-advance constraint, then:

  1. the interest elasticity of money demand is zero as long as the interest-rate is positive, and then
  2. the interest elasticity of money demand is infinite when the interest-rate hits zero.

In this case, the process of adjustment of the real interest rate in response to bad news about the future has two stages. In the first stage, 100% of the fall in the real interest rate is carried by a fall in the nominal interest rate, as the price level stays put because the velocity of money remains constant at the maximum technologically-determined rate allowed by the cash-in-advance constraint. In the second stage, once the nominal interest rate hits zero, and there is no longer any market incentive to spend cash keeping velocity up, 100% of the remaining burden of adjustment rests on the expected rebound inflation produced by an immediate and instantaneous fall in the price level. These two stages together carry the real interest rate down to where it needs to be, in order to incentivize the right amount of spending to preserve full employment.

The free-market solution to the problem created by an outbreak of pessimism about the future is thus to drop the nominal interest rate and then, if that does not solve the problem, to generate enough inflation in order to solve the problem.

Now we do not have the free-market distortion-free flexible-price economy that is the utopia of the Randites. We have an economy with frictions and distortions, in which the job of the central bank is to get price signals governing behavior to values as close as possible to those that the free-market distortion-free flexible-price economy that is the utopia of the Randites would produce.

In particular, our economy has sticky prices in the short run. There can be no instantaneous drop in the price level to generate expectations of an actual rebound inflation. If the central bank confines its policies to simply reducing the nominal interest rate while attempting to hold its inflation target constant, it may fail to maintain full employment. Even with the nominal interest rate at zero, the fact that the price level is sticky in the short-run may mean that the real interest rate is still too high: there may still be insufficient incentive to get spending to the level needed to preserve full employment.

A confident central bank, however, would understand that its task is to compensate for the macroeconomic distortions and mimic the free-market flexible-price full-employment equilibrium outcome. It would understand that proper policy is to set out a path for the money stock and for the future price level that produces the decline in the real interest rates that the flexible-price market economy would have generated automatically.

Thus a confident central bank would view generating higher inflation in a liquidity trap not as imposing an extra distortion on the economy, but repairing one. The free-market flexible-price distortion-free economy of Randite utopia would generate inflation in a liquidity trap in order to maintain full employment–via this instantaneous and immediate initial drop in the price level. A central bank in a sticky price economy cannot generate this initial price-level drop. But it can do second-best by generating the inflation.

All of my points above are implicit–well, actually, more than implicit: they are explicit, albeit compressed–in Paul Krugman’s original 1998 liquidity trap paper.

And yet I did not come to full consciousness that they were explicit until I had, somewhat painfully, rethought them myself, and then picked up on them when I reread Krugman (1998).

On the one hand, I should not feel too bad: very few other economists have realized these points.

On the other hand, I should feel even worse: as best as I can determine, no North Atlantic central bankers have recognized these points laid out in Paul Krugman’s original 1998 liquidity trap paper.

Central bankers, instead, have regarded and do regard exceeding the previously-expected level of inflation as a policy defeat. No central bankers recognize it as a key piece of mimicking the free-market full-employment equilibrium response to a liquidity trap. None see it as an essential part of their performing the adjustment of intertemporal prices to equilibrium values that their flexible-price benchmark economy would automatically perform, and that they are supposed to undertake in making Say’s Law true in practice.

But why has this lesson not been absorbed by policymakers? It’s not as though Krugman (1998) is unknown, or rarely read, is it?

It amazes me how much of today’s macroeconomic debate is laid out explicitly–in compressed form, but explicitly–in Krugman’s (1998) paper and in the comments by Dominguez and Rogoff, especially Rogoff…